SEGUNDA PUBLICACIÓN

4.2.3.1 the historic Basis of US Gas regulation

The natural gas industry in the US is made up almost entirely of private-sector companies. The transmission and distribution of gas have traditionally been treated as natural monopolies and are provided by utility companies operating under various state and Federal regulatory jurisdictions.

Production, except for a unique twenty-four year period from 1954 to 1978, has always been treated as a competitive industry and has not been subject to utility rate regulation.

The development of natural gas policy in the US has been heavily influenced by the constraints that have been placed on the exercise of Federal Authority by the US Constitution. There are two major constraints. Firstly, although Federal regulatory agencies, such as the current Federal Energy Regulatory Commission (FERC), are a part of the Executive Branch, their powers are created by acts of Congress and their authority is subject to review by the Supreme Court. Secondly, the Commerce Clause of the Constitution reserves jurisdiction over commerce to the states unless that commercial activity crosses state lines and is involved in ‘interstate commerce’.

In the case of natural gas, the implications of these restrictions are important. Many matters involving state regulation of oil and gas production and of local gas distribution have traditionally been the preserve of the state governments. It has thus been difficult for the Federal Government to implement a comprehensive gas policy from the wellhead to the burner tip without encroaching on state prerogatives. Unless Congress acts to extend Federal authority over the states under the guise of ‘interstate commerce’, and ultimately the Supreme Court agrees that the law is constitutional, the government must often work around existing restraints rather than dealing with them directly.

There have thus been a number of policies that the Federal Government has wanted to implement, but has often found itself unable to act upon unless it could get Congress to agree.

There have been five major policy turning points in Federal regulation of natural gas in the United States. Two of these were initiated by Congress, one by a Supreme Court interpretation of an earlier law, and two by major policy initiatives undertaken by FERC. They were:

The Natural Gas Act of 1938

The Supreme Court Phillips Decision – 1954 The Natural Gas Policy Act of 1978 (NGPA) 1.

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111 FERC Order 380 – 1984

FERC Order 436 (and subsequent modifications) – Beginning in 1985

The first of these is the underlying legislation under which the gas industry is regulated. The second, the 1954 Supreme Court decision, ushered in a period when wellhead natural gas prices were controlled by the Federal Government. The third, the NGPA, reversed the policy set in motion by the Supreme Court in 1954 and set the industry on the course of de-regulation. And the final series of FERC Orders now provide the basis for the presently restructured US gas industry.

4.2.3.2 the natural Gas act of 1938

The Natural Gas Act of 1938 is the landmark US gas legislation whose provisions still control company behaviour today unless they have been expressly amended by later legislation. The Act established Federal jurisdiction over natural gas companies operating in interstate commerce, and placed the authority to regulate the gas industry in the Federal Power Commission (FPC), later re-organised as the Federal Energy Regulatory Commission (FERC). By requiring that such companies charge

‘just and reasonable’ rates, the Act effectively subjected the interstate pipelines to the precedents established by the states for utility rate regulation. These, for the most part, are based on historic costs, allowing investors to recover costs plus a reasonable return on investment. This methodology is termed ‘cost-of-service’ rate regulation. The Act also established that companies obtain a

‘Certificate of Public Convenience and Necessity’ before expanding facilities or offering services. And it provided the mechanism for authorisation of imports and exports of natural gas. The early effect of the Certificate authority was to give the pipelines merchant monopoly control over the sale of gas in interstate commerce.

4.2.3.3 the Supreme Court’s Phillips Decision

In 1954, the US Supreme Court handed down a major decision in the case of Phillips Petroleum Co. versus the State of Wisconsin. Wisconsin had argued that its ability to regulate the rates of local distribution companies could not be effective as long as prices at the wellhead remained unregulated. By agreeing with the argument, the Supreme Court interpreted the Natural Gas Act as requiring ‘just and reasonable’ rate regulation of producers as well as pipelines. Thus, the Supreme Court effectively placed wellhead price controls on gas moving in interstate – but not in intrastate – commerce. Texas gas sold in Oklahoma was price controlled; Texas gas sold in Texas was not. Since the Court was interpreting existing natural gas law, any subsequent attempt to de-regulate wellhead prices required further Congressional action.

It gradually became apparent that wellhead price controls in their then-existing form were unworkable. By the late 1960s, the system was beginning to develop serious supply problems, and by the early 1970s gas shortages became increasingly severe, leading to supply curtailments of large customers. Gas markets were unable to clear since price-controlled gas was creating excess demand by under-selling higher priced, but unregulated oil and coal. At the same time unregulated intrastate gas buyers in Texas and Louisiana were freely able to outbid regulated interstate pipelines for the limited supply, thereby concentrating the shortages in the interstate market.

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The solution to the problems required new legislation from Congress, but the issue was politically charged and Congress was unable to agree on a solution. One group saw the problem as one of too little regulation and advocated the extension of wellhead price controls to the intrastate market.

This would have entailed a major Supreme Court test of the Commerce Clause. But a second group viewed price regulation itself as the problem, and advocated complete price de-regulation.

The debate, however, took place as world energy prices went through the upheaval of the first oil price shock, and complete de-regulation would have entailed sharp price increases to gas customers. Congress was not able to resolve the issue until it acted on a number of broader energy policy issues in 1978.

4.2.3.4 the natural Gas Policy act of 1978

The Natural Gas Policy Act of 1978 (NGPA) was one of several energy policy laws enacted in that year. It represented Congress’s attempt to deal with the breakdown of the wellhead price control system through a ‘partial de-regulation’ of wellhead prices. The emphasis of the Act was on solving the excess demand problem from the supply side through incentive prices for new supply and on reducing the intrastate purchasing advantage by placing intrastate gas under price regulation. Price de-regulation was to be phased. High cost gas was quickly de-regulated but most of the so-called

‘new gas’ was not to be de-regulated until January 1985 and old flowing gas was to remain ‘forever regulated’.

While a workable market system was the goal of this legislation, it actually imposed more stringent price regulation on many gas categories – albeit in many cases for a limited number of years – and thus was a ‘deregulation’ bill in name only. Since most gas remained price-regulated through the period when oil prices rose again under the influence of the second price shock, demand response through competition with oil was effectively neutralised.

The Act did, however, initiate the ultimate policy goal of market responsive pricing at the wellhead.

It also provided for more flexible transportation services on the pipelines, forming the basis for the ultimate transition to third-party access.

4.2.3.5 Industry response to the nGPa

In retrospect, the behaviour of the pipelines in contracting for new long-term supply during the seven-year NGPA transition period was unwise. They ended up with too high a delivery obligation at too high a price. They quickly found it difficult to sell system supply in competition with oil in the weakening oil markets of the early 1980s.

One of the pipelines’ major problems stemmed from the fact that the system encouraged cross-subsidies between price-controlled old supply and the newer contracts for which the pipelines were competing. They thus became very undisciplined in their pursuit of new long-term contracts and average wellhead prices rose rapidly (see Figure 24).

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1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 Decline in proved solve the shortages by increasing supply, and indeed the shortages quickly gave way to a chronic surplus. But the price effect on demand was even greater. US gas demand peaked in 1972 and it did not exceed that peak again until the year 1995, 23 years later. At one point US demand was actually 27% less than it had been in 1972. The result was a substantial – and continuing – surplus that came to be known as the ‘gas bubble’. The behaviour of demand and supply during this period is outlined in Figure 25.

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Figure 25:   US Natural Gas Annual Consumption during the ‘Gas Bubble’ Period

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1970 1980 1990

Consumption

The “Gas Bubble”

FERC order 380 Passage of the NGPA

Bcm

Source: Jim Jensen

Because of the surplus, strong competition developed among producers to sell short-term gas, and spot prices fell substantially, well below most pipelines’ costs of system supply (the ‘weighted average cost of gas’ or WACOG). The NGPA had provided special transportation options for local distribution companies (LDCs) and other pipelines to buy from other than their contracted suppliers.

However, in the face of declining overall demand and their long-term contract commitments, many of these buyers could not take advantage of the cheap gas supply. There was low-cost new gas available for purchase and the third-party transportation option to acquire it, but the LDCs and pipelines could take only limited advantage of it.

4.2.3.6 FErC Order 380

In 1984, FERC addressed the issue with its Order 380. The pipeline system consisted of long-term contracts between producers and the merchant pipelines, and these were matched by long-term contracts with utility buyers, such as LDCs and other pipelines. The pipeline re-sale contracts generally had minimum bill provisions that acted in the same way as take-or-pay provisions in the producer contracts.

In Order 380, FERC relieved the utility purchasers from any contractual obligation to the pipelines for minimum bills for system supply they elected not to take. Thus, if the LDCs found their pipeline suppliers WACOGs to be over-priced, they could buy lower-cost spot gas direct from producers and have it moved to them through the transportation flexibility afforded them through the NGPA. As is evident from Figure 24, average prices dropped substantially.

115 4.2.3.7 FErC Order 436

The NGPA had not made transportation flexibility directly available to end users. To further restructure the industry, FERC issued a comprehensive open access policy in Order 436. It required that third-party access be available on a non-discriminatory basis to all comers (thereby putting an end to selective transportation) and specified rate design guidelines under which it would be offered. Although Order 436 was subsequently modified by additional orders, it was the turning point in the development of full third-party access.

4.2.3.8 the Pipeline take-or-pay Problem

A number of the pipelines had take-or-pay problems before Order 380. The effect of Order 380, however, was to provide contractual relief from revenue guarantees in an unbalanced way. While the LDCs no longer had to honour their guarantees to the pipelines, neither the FERC nor Congress were willing to address the more controversial revenue guarantee issue at the pipeline / producer interface. Hence, Order 380 substantially intensified the pipelines’ take-or-pay problems.

Between 1984 and September 1989, the pipelines accumulated nearly $30 billion in take-or-pay obligations. While the FERC encouraged pipelines and producers to work out their contract problems among themselves, the thrust of FERC policy seems to have been to place the pipelines in a vulnerable position where they would be forced to seek relief from the producers by re-negotiating market-responsiveness into their contracts. This is what actually happened, but at a settlement cost to the pipelines of approximately $9 billion.